MONETARY POLICY

Monetary policy refers to the credit control measures adopted by the central bank of a country to influence the level of aggregate demand for goods and services or to influence the trends in certain sectors of the economy. Monetary policy operates through varying the cost of availability of credit. These variations affect the demand for and supply of credit in the economy and the nature of economic activities. Monetary policy rests on the relationship between the rates of interest in an economy, that is, the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Rapid economic growth Equal income distribution Full employment

Objectives
Neutality of money Price stability Exchange rate stability

TYPES OF MONETARY POLICY

Monetary policy is of various types depending on the type of instruments which are used for its operations, target variable and long term objectives used to achieve these. MONETARY POLICY TYPE Inflation Targeting Price Level Targeting Monetary Aggregates Fixed Exchange Rate Gold Standard Mixed Policy TARGET MARKET VARIABLE Interest rate on overnight debt Interest rate on overnight debt The growth in money supply The spot price of currency The spot price of gold Usually interest rates LONG TERM OBJECTIVE A given rate of change in the CPI A specific CPI number

A given rate of change in the CPI the The spot price of the currency Low inflation as measured by the gold price Usually unemployment + CPI change

TOOLS OF MONETARY POLICY

QUATITATIVE TOOLS Open Market Operations (OMO) Sales or purchases of government debt instruments (treasury bonds, treasury bills, treasury notes) on the open financial markets by a country's central bank as part of its efforts to influence the size of the money supply and the levels of interest rates. Central bank decisions to buy up government debt instruments is based on:
EXPANSIONARY MONETARY POLICY It increases the total supply of money in the economy more rapidly than usual It is traditionally used to try to combat unemployment in a recession by lowering interest ates in hope that easy credit will entice businesses into expanding CONTRACTIONARY MONETARY POLICY It expands the money supply more slowly than usual or even shrinks it It is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values

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Cash Reserve Ratio (CRR) The portion or percentage of Depositors balances banks must have on hand as cash. It is a requirement determined by countrys Central Bank. It Affects money supply in a country. e.g.: if CRR in India is set at 6% and the banks total deposits are in tune of Rs 100 Cr then Rs 7 Cr is required to be kept as reserve.

Repo-Bank Rate It is the rate at which banks borrow money from the RBI, When Repo-Bank Rate is increased money supply in the economy decreases. Reverse-Repo Rate It is the rate at which the RBI absorbs liquidity from the system, or the interest rate paid to banks for RBI's borrowings from them. Statutory Liquidity Ratio (SLR) It is that amount which a bank has to maintain in the form of cash, gold or approved securities. The ratio is derived broadly on the total demand and time liabilities of a bank. Bank Rate The minimum rate at which the central bank provides loans to commercial banks.

QUALITATIVE TOOLS Rationing of Credit Limitations are put on the available credit to large corporate houses and a higher interest is being charged over a certain specified credit limit. Lending Margin changes Loans are being provided only upto a certain level of mortgage property. This gap between the advanced amount and mortgaged propertys value is termed as lending margin. Moral Suasion It is a method by which commercial banks are being convinced to give credit in advance which is in accordance with the central bank directives in the interest of betterment of the economy. Controls If other measures/ tools prove in-effective, then some direct controls can be adopted which outlines clear set of rules guiding the banks to lend on specific terms only.

INDIAS POLICY REVIEW

Indias monetary policy is being reviewed by Reserve Bank of India 8 times/ year (4 quarterly and 4 mid-quarter). The latest review as of 26th July 2011 is as follows: Measures taken by RBI are aimed at reducing the present levels of inflation:

Repo rate is increased by 50 Basis points and it reached now 8 %

Reverse repo rate is automatically increased and adjusted to 7%

Marginal Standing facility(MSF) which is introduced recently has been fixed at 9%( 1% above Repo rate)

The reasons for increase in rates can be: Ever rising rates of inflation in India Uncertainty on the global level due to global economic crisis Efficient management of the transmission system of monetary policy Attempt to reduce the gap- bank deposits and credit Stabilization and control of BOPs (balance of payment)

LIMITATIONS
1. Forecasting Problem: To form a monetary policy, reliable and proper assessment is required to judge the intensity of problem (inflation/recession) which will help in laying down correct measures of policy based on such forecasting. 2. Time Lag: There exists a time lag between action, implementation and working of any policy which restricts its entire scope. 3. Non-banking intermediaries: Changes in financial market have adversely affected the scope of monetary policy. 4. Capital markets and money: These are under-developed in less-developed and developing countries and restrict the scope of monetary policy.